Malaysia Gloves Sector - Maybank Kim Eng 2020-06-24: A Growing Pie For All Players

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TOP GLOVE CORPORATION BHD (SGX:BVA)

Malaysia Gloves Sector - A Growing Pie For All Players

Too cheap to ignore; top pick is Top Glove

• Demand switch to nitrile gloves (from vinyl gloves) is prevalent in the developed markets and we think China could catch-up with this trend in the coming years. Taking into consideration of the aggressive supply from China, we think industry demand-supply could balance in 2H21, and oversupply risk is likelier in 2022. In our earnings estimates, we have already assumed for lower ASPs in 2021-22E.
• Our top pick remains Top Glove (SGX:BVA) (BUY, Target Price MYR21.90) for its faster near-term ASP hikes and undemanding CY21E P/E of 17x (below 5-year mean of 19x).

US: Moving away from plastic vinyl gloves

Vinyl gloves: The ‘poison plastic’ gloves

• Vinyl gloves are made out of polyvinyl chloride (PVC), which produce dangerous quantities of dioxin and other carcinogenic emissions across their life-cycle (from manufacturing to landfill disposal). Additionally, some of the vinyl gloves are also found to contain toxic plasticizer chemicals called ortho-phthalates (THAL-eights) that can leach into food.
• As a result, the demand has gradually switched from vinyl to nitrile rubber gloves in the US, and we note that the trend started as early as 1999, for the medical gloves segment. The key hindrance for switching lies in the cost as nitrile gloves ASP is > 50% higher than that of vinyl gloves.

Medical: Switching started as early as 1999

• Kaiser Permanente, one of the larger healthcare providers in the US, had switched from vinyl gloves to nitrile gloves in 1999 due to the toxicity concern. We note that the plastic medical gloves demand in US peaked in 2008-12, and has been on a steady declining trend since 2013. However, the vinyl medical gloves have yet to be fully phased out, and plastic medical gloves accounted for 5% of US total glove import value in 4M20.

Food industry: Switching accelerated in 2019

• For the food industry, the safer alternatives are nitrile and polyethylene gloves (i.e. PE gloves). The PE gloves are also a type of plastic gloves, but are safer than vinyl gloves as they do not cause dioxin pollution and do not contain the toxic plasticizer. However, the quality of PE gloves is inferior to that of nitrile as PE gloves are loose-fitting, less durable and not impervious to liquids. Hence, if one is not budget-constrained, the preference would still be for the nitrile gloves.
• We note that the demand switch started gradually in 2018, and was only more apparent in the numbers in 2019, with US import value of plastic non-medical gloves falling 22% y-o-y (partially due to lower vinyl glove ASP). In 4M20, US import value of plastic non-medical gloves fell 9% y-o-y (despite higher vinyl glove ASP) and plastic non-medical gloves accounted for 12% of total US gloves import value. Further switching ahead would accelerate the demand for nitrile gloves.

Huge market share gains potential in developing markets

• In US, plastic accounts for c.17% of US glove import value, and we believe rubber gloves could displace 5-10% of the plastic glove market size in the coming years, if US fully phases-out vinyl gloves, and there is still demand for the cheap PE gloves.
• We believe developing markets, such as China and India, are predominantly using vinyl gloves and may also steadily switch to nitrile gloves in the coming years. In total, China and India account for only c.5% of Malaysia’s export volume, despite their big population size (35% of world’s population).

China: Supply to US and demand outlook

US lifted import tariffs on China’s gloves in mid-Mar 2020

• Due to the severe gloves shortage, the US has lifted the punitive import tariffs on China’s gloves in mid-Mar 2020. Presently, the import tariff on China’s rubber examination gloves has reduced to zero (from 7.5% under the ‘Phase 1’ trade deal in Jan 2020 - the original import tariff was 15% in Sep 2019).
• Meanwhile, the import tariff on China’s non-medical rubber gloves has been reduced to 3% (from 28%). The recent revisions have leveled the playing fields for all the key gloves-exporting countries. As for the plastic gloves, there have been no import tariffs imposed as China is almost the sole supplier to the US (i.e. no alternatives).
• Following the exemption of import tariffs, US imports of China’s exam gloves doubled m-o-m in Apr 2020 on low base effect, with China’s market share increasing to 15% in Apr 2020 (vs. 71% for Malaysia). Despite the higher supply from China, gloves supply is still tight in the US and glove players from the key producing countries (i.e. Malaysia, China and Thailand) managed to push through higher ASPs from Mar 2020 until now.
• Post-COVID 19, we think the US may reinstate the punitive import tariffs on China’s exam and non-medical gloves, which may result in China losing market share in the US again.

China may also phase out vinyl gloves

• The rubber glove penetration rate is extremely low in China, with consumption per capita of only 8 pieces, compared to 90-300 pieces in the developed markets. In our view, the low rubber gloves consumption in China could be due to their heavy reliance on vinyl gloves, which is produced locally.
• Given the toxicity of the vinyl gloves and China’s government policies in reducing environmental pollution over recent years, we believe China’s end-demand may also steadily switch to nitrile gloves. Hence, China’s glove-makers will need to embark on aggressive nitrile glove capacity expansion plans to cater for the huge local demand, which would otherwise be met by higher imports. That said, there would still be demand for the cheaper vinyl gloves and we note that China is moving its vinyl glove production to Vietnam.
• In the event that China’s rubber gloves consumption grows and eventually matches developed market’s rubber glove consumption of 90 pieces per capita (low-end of the range), we estimate that China’s rubber glove market size could jump 11x to 125.4b pieces (from around 11.1b pieces presently), accounting for half of global rubber glove market size of c.263b pcs in 2019.
• We believe China’s migration to rubber gloves could be supply-led in the next 5 years, in view of the local players’ aggressive capacity expansion in the nitrile space.

China importing more from Malaysia

• China accounts for approximately 3% of Malaysia’s glove exports volume. Though the infection rate of COVID-19 has reduced to almost zero in China, we note that China’s demand for Malaysia’s rubber gloves is still higher than pre-COVID 19 levels. In Apr 2020, Malaysia’s rubber exam glove export to China was 2.2x higher than the pre-COVID 19 level in Dec 2019 (in value terms) and we understand that the demand from China remains elevated until now. Additionally, China is also paying higher ASPs, similar to the ASP hikes in other markets. The strong demand could be due to the stock replenishment requirement and also preparation for a potential second wave.

Alook at China’s glove-makers

Blue Sail: To add 30b pieces nitrile capacity in 3 years

• Blue Sail could be China’s largest glove producer, with its capacity predominantly in vinyl gloves (or PVC gloves) and less in other gloves (nitrile, latex, surgical). In FY19, the glove division accounted for 48% of the group’s revenue and 9% of group pretax profit, on a pretax margin of just 3% (vs. 9-19% for Malaysia’s Big4). In FY19, the glove division registered revenue of CNY1.7b (or MYR1b) and pretax profit of CNY53m (or MYR32m).
• Presently, it has a total production capacity of c.20b pcs p.a., out of which, c.15b pcs p.a. is from vinyl gloves, c.4b pcs p.a. is from the nitrile gloves and the balance c.1b pcs p.a. is from other gloves (i.e. surgical, latex).
• In 2020, following the convertible bond fundraising exercise, Blue Sail plans to add total new capacity of 6b pcs p.a., out of which, 4b pcs p.a. is for the vinyl gloves and 2b pcs p.a. is for the nitrile gloves.
• Just recently, in June 2020, the company laid out its aggressive expansion plans for the next 3 years:
  1. Nitrile gloves – To build total new capacity of 30b pcs p.a. by Dec 2023, with capacity construction to commence in 3Q20. The Phase 1 of the expansion will see 10b pcs p.a. capacity commencing trial run in mid-2021. Meanwhile, the trial run of Phase 2 is scheduled for Dec 2021 but the capacity size is not mentioned. Given that the expansion plan is up to Dec 2023, we think the entire expansion may only complete in 2023 and the company may adjust its expansion plan according to market demand; and
  2. Vinyl gloves – Only adding 800m pcs p.a. vinyl gloves capacity in Vietnam.
• Adjusting for the timing of the capacity commencement dates, we estimate that Blue Sail’s effective nitrile glove capacity growth would be 25%/153%/151%/13% in 2020-23E. The growth rate looks alarming due to its low nitrile glove capacity base of just 4b pcs p.a. presently. In terms of the absolute new capacity, its growth rate is 1b pcs/7.7b pcs/19.2b pcs/4.2b pcs over 2020-23E; this is similar to the expansion pace of Top Glove but faster than the other key players in Malaysia and Thailand.
• Our estimated effective nitrile capacity for Blue Sail represents 0.3%/2%/5% of our projected global rubber glove demand in 2020-22E. This reaffirms our belief that supply will catch up with demand in 2021 and oversupply risk is likelier in 2022.
• Including the vinyl gloves, Blue Sail’s total capacity could be 60b pcs p.a. by end-2023, with total nitrile gloves capacity of 36b pcs p.a. This would still be smaller than our expected rubber glove capacity size of 40-110b pcs p.a. for the Big 5 by end-2023.

Intco Medical: To add 45b pieces nitrile capacity in 5 years

• Intco Medical could be China’s top 3 glove producer by capacity. It manufactures a wide range of healthcare products:
  1. gloves (i.e. vinyl, nitrile);
  2. medical equipment (eg. wheelchair, over bed table, cane/walker, shower chair);
  3. nonwoven disposables (eg. protective gowns, caps, face shield, shoe cover); and
  4. other products (eg. hand sanitizer gel, hot/cold packs).
• However, there is no segmental earnings breakdown for us to gauge its gloves earnings/margins.
• In FY19, the group recorded revenue of CNY2.1b (or MYR1.3b) and pretax profit of CNY203m (or MYR123m) on pretax margin of 10% (similar to Malaysia’s Big4). In 1Q20, its pretax profit jumped to CNY152m (or MYR92m) on a higher pretax margin of 20%. We think 1Q20 earnings could be partially boosted by exceptional gains as its operating income jumped to CNY150m (+CNY125m y-o-y) and accounted for almost the entire pretax profit in 1Q20.
• In 2019, Intco Medical’s total production capacity stood at approximately 19b pcs p.a., out of which, vinyl accounted for 14b pcs p.a. and nitrile accounted for 5b pcs p.a. Intco Medical’s total glove capacity size is similar to that of Blue Sail.
• Intco Medical has also laid out aggressive expansion plans for the next 5 years. By end-2025, its total capacity could be approximately 78b pcs p.a., out of which 50b is slated for nitrile glove capacity.
• According to media reports, Intco Medical will commercialise 20 nitrile glove production lines and 19 vinyl glove production lines in 2020, totaling 9b pcs p.a. capacity. The target commencement dates for the new capacity are May and Sep 2020. We estimate that Intco Medical’s effective nitrile glove capacity growth would be 64%/103%/48%/32%/24%/20% in 2020-25E. In terms of the absolute new capacity, its growth rate is 3.2b pcs/8.5b pcs/8.0b pcs over 2020-22E.
• Our estimated effective nitrile capacity for Intco Medical represents 1%/2%/2% of our projected global rubber glove demand in 2020-22E. We think the market would be able to absorb the new supply from Intco Medical as we project global demand to grow 20% p.a. in 2020-21E.

China has no cost advantage over Malaysia

• According to media reports on Blue Sail, the capex for each vinyl production line is CNY8m (or MYR5m) and construction takes 8 months. As for the nitrile gloves, capex for each production line is CNY26m (or MYR16m) and construction takes 12 months. We note that the capex per nitrile production line is similar to Malaysia’s players (i.e. MYR15-20m), and hence, we believe there is no construction cost advantage in China.
• In terms of production costs, China’s cost could be similar or more expensive than that of Malaysia:
  1. NBR raw material – This is the biggest cost item. Similar to Malaysia, China also has local NBR raw material supply but the capacity is relatively small. So, China’s glove producers will also need to import its NBR raw material;
  2. Gas – This is the second biggest cost item and the cost of gas in China is around 45% higher than in Malaysia;
  3. Labour – This is the third biggest cost item and the wages in China is about 2% lower than that of Malaysia.
• Additionally, China has abundant worker supply while Malaysia relies on foreign workers.

Maybank-KE’s demand-supply projections

Global demand: +20% p.a. in 2020-21E

• The global demand in 2020-21 would be supply-led as there is not enough capacity to cater to the sudden demand jump stemming from COVID-19. For the world’s Big 5 (i.e. Top Glove, Hartalega, Kossan, Supermax and Sri Trang Agro (SGX:NC2)), we estimate combined effective capacity growth of 16%/19% in 2020-21E. Accounting for capacity growth from other players, we project global demand to grow 20% p.a. in 2020-21E.
• For Blue Sail and Intco Medical, we estimate that the combined new capacity from the two China’s glove players would account for 1% and 4% of our 2020-21E global demand. Given the stock replenishment requirement and the long sales lead time into mid-2021, we believe the market would only reach equilibrium in 2H21, and short-medium term oversupply risk is low.

Oversupply risk potentially in 2022E

• For 2022E, we assumed for 8% global demand growth rate (similar to its historical 5-year CAGR). We estimate combined effective capacity growth of 12% for the Big 5. For Blue Sail and Intco Medical, the combined new capacity looks alarming as it would account for 7% of our projected global demand in 2022E. However, we think the new capacity could be absorbed by its local China market as it needs to replace some of its vinyl gloves consumption with nitrile.
• Moreover, given that the margins of the China glove-makers are not superior to that of Malaysia’s glove-makers, we believe the ASP pressure from the China peers may not be excessive in an oversupply situation.
• We also believe that the China players are rational and would adjust their expansion plans according to the market’s demand. An irrational expansion will also jeopardise their profitability and return on investment (ROI).

Malaysia glove sector stocks valuation comparison

• See Fig28 in PDF report attached below for comparison of Top Glove (SGX:BVA), Hartalega, Kossan, Supermax & Comfort Glove.

Lee Yen Ling Maybank Kim Eng Research | https://www.maybank-ke.com.sg/ 2020-06-24

SGX Stock Analyst Report BUY MAINTAIN BUY 21.900 SAME 21.900